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An oligopoly is when
four companies have more than 50% of the market.
Across the Atlantic, two companies have more than 50% and
four companies have 90%.

Part of a series on airline competition
- see extra articles listed in the right hand column.

Economic textbooks are full of
the theory and explanation of how monopolies and oligopolies can
break the ideal balance between commerce and consumers, and
while economists rarely agree on much, there is close to
universal agreement that a few major companies dominating a
market is a bad thing.

Let's take the theory and see
if it applies to the airline industry as it presently is in the
US and across the Atlantic.

The Reality of Airline Market
Dominance

When is a market 'dominated'
by one (or more than one) airline(s) and when is a marketplace
fairly competitive?

We quote the
generally accepted
definitions of oligopolies and monopolies in part one of
this article series. Basically, any time four (or
sometimes more; and of course, definitely if fewer) companies
have 50% or more of a market, this is probably an oligopoly, and
if these four (or fewer) companies control more than 80% of the
market, it is most likely a monopoly (even though more than one
company is present).

The four largest carriers
have 60.1% of the total market (in terms of passenger miles
flown) and so, on the face of it, seem to be in an oligopolistic
situation.

Interestingly, if the merger
between Northwest and Delta had not been allowed to proceed, the
four largest carriers would then be AA, DL, UA and CO, with a
51.8% market share between them - right on the cusp of becoming
an oligopoly. The DL/NW merger, between the formerly
second and sixth largest carriers (as measured by passenger
miles flown) has now cemented the assumption in place that the
airline industry is oligopolistic.

The previous major merger -
between US Airways and America West - resulted in the new merged
carrier taking the sixth place on this list. There is also
a secondary measure of oligopolistic markets that looks at the
market share belonging to the eight largest competitors - so
this merger concentrated more power in the eight largest
airlines, while not affecting the market power of the four
largest airlines.

A mooted future merger
between United and Continental, should it subsequently occur,
would combine the third and fourth largest carriers, moving
Southwest up to the fourth slot, and would therefore concentrate
69.3% of the market into the top four carriers. This would
definitely tilt the market appreciably further towards being
severely oligopolistic.

The reality is worse than this
table suggests

This summary table is
however deceptively optimistic in its nature, because it
conceals within the totals lots of market pairs and lots of
cities where the market isn't split into a somewhat
oligopolistic situation with four carriers controlling 60% of
the market, and with many other smaller carriers also actively
present. As you surely know from personal experience, we
have 'fortress hubs' and strategic routes where instead of four
airlines sharing 60%, one airline alone might have 60% (or
more), creating not just oligopolistic service but near
monopolistic service for many routes.

The real scenario is that
there are lots of monopolistic markets within the broader total
US market, with some airlines controlling some monopolies, and
other airlines controlling other monopolies, such as to sort of
'average out' and, in summary, look more benign than the
underlying actuality of routes and cities.

Trans-Atlantic market
statistics

Let's also look at the
international market, using DOT figures for the 12
months ended June 2009 as reported in their Show Cause order
tentatively approving the AA/BA anti-trust immunity application.

In this situation, where 19 airlines have collapsed themselves into three
anti-trust immune alliances, and where they hold 82.9% of the market between them
(or 87.5% if US Airways is added in with the rest of its Star
Alliance partners),
this is not just an oligopoly by all measures, but probably a
textbook monopoly (monopolies can have more than one major
player).

And so we feel sadly justified in describing this
event (anti-trust immunity being granted to the Oneworld
Alliance) as marking the death of airline competition (across
the Atlantic).

Other Factors To Test for
Oligopoly/Monopoly

The market share test we've
used in the preceding tables is a simplistic test that isn't
always completely correct, and so, in cases of doubt, economists
use some additional tests to see not only if the numbers show
there could be an oligopoly, but to confirm if companies are
indeed acting that way.

Sometimes, oligopolies can
be present when companies have smaller market shares than the
theory would suggest, other times, oligopolies are not present
even when companies have much larger market shares than needed
to cross the threshold level for oligopoly.

These tests are discussed in
detail
here and
here. To boil down the economic theory into key
bullet-point type concepts, oligopoly can be considered by
marketplace characteristics and marketplace behaviors.

The marketplace
characteristics have three main elements :

Small number of suppliers
who between them control most of the market : We've
spoken before about measuring markets in terms of the total
share owned by four and sometimes eight companies, but
oligopolies can sometimes have as many as about 20 different
companies, depending on other conditions.

Barriers to Entry :
It is difficult for new companies to enter the market.
Maybe there are huge capital investments required, long
leadtimes, legislative restrictions, limited resources, or
patent restrictions.

Common Product Types :
Members of an oligopoly provide similar products, perhaps
with no distinction at all (eg raw materials such as metals
and foodstuffs) or perhaps with distinction/branding but
very similar functionality (eg automobiles).

The marketplace behaviors
are

Interdependence :
This is a key measure of an oligopoly. The actions of
each company in the marketplace influences the market as a
whole, and will cause the other oligopolies to react/respond
- not necessarily to copy, but in some way or another to
respond. This means that each company, in choosing new
products, prices, or other changes to their activities
considers not just how the marketplace will respond but also
how their fellow oligopolies will respond.

Mergers and Collusion
: Because there are few companies in an oligopoly,
mergers or collusion give the companies involved substantial
extra marketplace control. Companies have a
tendency/preference to merge or collude with each other
rather than to compete.

Nonprice Competition :
Oligopolies would prefer not to compete on price, preferring
instead to create differentiations of products (that may be
as much illusion as reality) and to advertise and promote
their brand and products.

Think about the airlines
under these two sets of three parameters. Small number of
suppliers? Check - see the tables above. Barriers to
entry - check. Starting an airline is a time consuming
capital intensive business, needs regulatory approvals, and
needs access to scarce resources (airport gates, etc). And
all airlines, much as they pretend to the contrary, provide the
basic identical service - a flight that lasts about the same
duration, between the same cities, on the same plane, in the
same sort of seat, for the same price.

As for the second three, we
see interdependence all the time. An airline will try and
raise prices, and if the other airlines don't follow, it will
bring its prices back again. An airline will introduce a
new service (or fee) and the other airlines generally copy.
Airlines are aggressively seeking to merge or collude, either
officially with DOT permission or unofficially through backdoor
arrangements (such as alliances) and sometimes through
methodologies of dubious legality such as 'signaling' possible
price rises. Lastly, airlines attempt not to compete on
price, choosing to charge almost exactly the same fares.
Instead they choose to promote things such as their frequent
flier programs, their lounges, and - well, there's not much
else, is there.

By all of these measures,
airlines are exhibiting oligopolistic behavior.

Are Oligopolies Good or Bad

Not all oligopolies are bad.
Some can be good. The extra profit potential for a company
in an oligopolistic market can be used to fund new product
development, service enhancements, and so on (think computers
for a vivid example of this). And the large sized
companies can enjoy substantial economies of scale as a result
of their large sales volumes.

But, for reasons beyond the
purview of this article series, airlines are seldom profitable,
and in any case, even if they had excess profit to invest in
R&D, most of the need for R&D in the airline/aviation industry
lies in related fields - aircraft design and manufacture and air
traffic control in particular.

And, as discussed in the
second part of this series, the nature of the airline business
does not allow for economies of scale; indeed, paradoxically,
the bigger airlines are less efficient than the small ones.

So neither of the two main
potential benefits of oligopolies apply to the airline
oligopoly.

Let's hope the two downsides
of oligopolies also don't apply. They are a risk of
inefficiency, and a concentration of wealth and social power.

Oligopolies can be even more
inefficient than monopolies. Monopolies are more closely
subject to legislative and social scrutiny, oligopolies are less
visible so can get away with more. Many people don't even
know what an oligopoly is, thinking there to be only two types
of market - monopolistic and competitive.

As we saw in the second part
of this series, the bigger the airline (and therefore the more
it is part of the oligopolistic process) the higher its costs
and the less efficient it was (which its profits did not grow in
line with its costs/revenue). Airlines would seem to
suffer from this downside aspect of oligopolies.

While the concentration of wealth is not bad unto itself,
such wealth can then be used (or abused) to exert influence
over the economy, the political system, and society, which
might not be beneficial for society as a whole.

Doesn't that describe the
airlines and their very efficient government lobbying processes?
They have an amazing example to stall passenger friendly
legislation, and to draw out requirements for expensive
retrofits to their fleets proposed by the NTSB on safety
grounds.

Aren't the airlines hovering
in the 'too big to fail' category, possibly abusing the Chapter
11 process, and being subject to supportive Presidential
intervention in the past when it seemed they were about to be
impacted by labor strikes?

It seems that while airlines
have neither of the redeeming upsides to their oligopolistic
nature, they do suffer strongly from both the classic two
downsides.

Summary

The airlines meet the
classic tests for being oligopolies - both the quantitative
numerical test and the more qualitative other observations of
their characteristics and behaviors.

Although oligopolies can
sometimes bring consumer benefits, the airline tie-ups seem to
do no such thing, but rather bring out the potential downside
negative aspects of such business arrangements.

Recent merger approvals have
cemented in place the oligopolistic nature of the airlines.

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Originally published
12 Mar 2010, last update
19 Dec 2013

You may freely reproduce or distribute this article for noncommercial purposes as long as you give credit to me as original writer.